Vitalik Buterin, founder of Ethereum (though not of the DAO).

Photographer: John Phillips/Getty Images for TechCrunch.

Blockchain Company Wants to Reinvent Companies

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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One of the great joys of our modern age, with its rapid advances in financial technology, is examining the latest innovation to try to figure out what centuries-old idea has been dressed up in cryptographical mystification. Sometimes this is pretty easy. Ethereum, the fascinating blockchain/smart-contract platform, has a pyramid scheme helpfully named "Ethereum Pyramid Contract." The innovation is calling the pyramid scheme a pyramid scheme. (Also, blockchain!)

But Ethereum also has the DAO.  Can you figure that one out? Here's how the Wall Street Journal describes its innovation:

Can a company run itself without executives or managers or a board of directors? One of the more radical experiments in technology aims to find out.

Here's how the DAO's "Principles" page defines it:

The DAO is a Decentralized Autonomous Organization (“DAO”) - more specifically, it is a new breed of human organization never before attempted. The DAO is borne from immutable, unstoppable, and irrefutable computer code, operated entirely by its members, and fueled using ETH which Creates DAO tokens.

("ETH" is Ether, the bitcoin-like virtual currency of Ethereum.) Here's Fortune:

The DAO is being touted as a model for a new kind of organization, created and run using blockchain software rather than conventional corporate structures.

Nearly everything having to do with Bitcoin and blockchain sounds like some mix of sci-fi, magic, and a pyramid scheme, so bear with us as we try and unpack all that.

Nah, let's skip ahead. An organization with no managers or board, in which every investor "gets a vote ... proportional to their holdings," is called a "partnership." Solved it! The general partnership for a business purpose was called "societas negotiationis alicuius" in Roman law. So it predates, by a millennium or two, the blockchain. It's closer to the age of belief in magic -- or, for that matter, the age of the pyramids -- than it is to science fiction. 

Of course, I tease because I love. Ethereum and the DAO didn't invent the partnership, but they do seem to be doing cool things with smart contracts, that is, contractual relationships that are automated and embedded in computer code. And the DAO isn't organized along quite the same lines as, say, a law firm partnership. It's sort of a combination venture-capital/crowdfunding/conglomerate platform : Everyone who invests -- it has raised more than $107 million so far -- gets voting shares in the partnership/fund/DAO/whatever, and can then vote on how to allocate the fund's money to projects. The projects will be performed by ... well, managers:

The DAO is software: it does not have the capabilities to manufacture a product, write code, develop hardware or sweep the streets. It requires actors in the physical world for most tasks—these are called Contractors.

The DAO is free to work with as many or as few Contractors in the real world as it sees fit. Contractors submit Proposals for the development of products or services—these Proposals are written in plain English and backed by a software code in the form of a smart contract that defines the relationship between The DAO and the Contractor: deliverables, responsibilities, and operating parameters.

So the DAO is essentially an investing partnership that votes on all investing decisions, whose bylaws are embodied in, and whose administrative functions are performed by, smart contracts. And its relationships to its investments -- the Proposals -- are also embodied in smart contracts. In theory, I suppose, the DAO's partners could vote to invest in a project in exchange for a fixed or equity-like financial return (like a venture-capital investment), or to fund a project that then becomes part of the DAO organization itself (like a division of a conglomerate), or to pay cash for outside services (like hiring a programmer to write its smart contracts), or to just give money to a charity project, or to do anything else that can be coded into a smart contract. Much like a general partnership can make an investment, or start a business, or pay for services, or give to charity.

The autonomous-organization/smart-contracts/no-managers stuff is to some extent a distraction: It's relatively easy to automate the operations of a company whose only business functions are (1) to vote on what projects to fund and (2) to disburse funds to (and collect payments from) those projects. The real operating work of, like, building self-driving cars, or motivating people to build self-driving cars, will be done at the project level, by humans. Humans who are really into smart contracts, but humans nonetheless.

All of this is trivially replicable using old-fashioned governance structures. Berkshire Hathaway would look a bit like the DAO if, instead of leaving things to Warren Buffett, all of its shareholders got to vote on every investment decision. When I put it like that you can probably see why this structure has not been super popular so far. But who knows! Maybe the DAOers will be really good at picking winners, and putting them into smart contracts.

More generally, we live in a golden age of corporate-governance experimentation, what with the crowdfunding and the private-market fundraising and Mark Zuckerberg's undying grip on Facebook's voting shares. Autonomous-ish organizations and smart contracts provide particularly delightful laboratories for that experimentation, and as a way to democratize venture capital they are not obviously worse than regular crowdfunding.

There are some weird things about them though. First, smart contracts put a lot of onus on their readers to be smart. Here is a proposal for The DAO from Slock.it. Or rather, it is not the proposal, it is an overview of that proposal for "Overview/Educational purposes only -- for actual terms please refer to the Proposal Smart Contract on the Blockchain (address TBD)." The only way to know for sure what you're agreeing to, with this proposal, is to read the smart contract's source code.  

It would be too much to say that regular contracts are written for humans to read, while smart contracts are written for computers to read. Really regular contracts are written for lawyers to read, and it is entirely possible that computers have a stronger preference for clarity and simplicity in their reading materials than lawyers do. Many ideas are probably expressed more clearly in code than they are in legalese. 

But the U.S. legal system has built up a pleasantly redundant system of safeguards so that investors usually get more or less what they expect. If you invest in a U.S. public company, you are in a sense signing up for a certificate of incorporation and bylaws, which are written in lawyerly language. But you also get a prospectus that explains the terms of your investment in relatively (relatively!) plain English. Also the terms of that investment -- how you vote, what duties the company owes you, what rights you have, etc. -- tend to be constrained by federal securities law, state law, stock exchange listing requirements, underwriter due diligence, public policy, custom and tradition. Even if you invest in a company whose bylaws say that the board of directors can sacrifice you to a demon on the first full moon of a leap year, it's unlikely that that term would be enforced. There is only so much leeway to depart from the standard terms.

If you invest your Ether in a smart contract, you'd better be sure that the contract says (and does) what you think it says (and does). The contract is the thing itself, and the only thing that counts; explanations and expectations might be helpful but carry no weight. It is a world of bright lines and sharp edges; you can see why it would appeal to libertarians and techno-utopians, but it might be a bit unforgiving for a wider range of investors.

Meanwhile there is this weird idea from "Stephan Tual of Slock.it, the startup that wrote the DAO's code":

“It’s not bound by terms of law and jurisdiction,” said Mr. Tual. “It’s bound by code.”

Nothing here is ever legal advice, but I'd advise Mr. Tual to consult a lawyer, preferably one with a license from somewhere other than the Land of Ethereum.  The notion that uttering the word "blockchain" somehow exempts you from national regulation is a popular one -- we have talked about it before -- but it is not widely shared by national regulators. Everything that happens in a place is bound by the law of that place, and things that happen on the internet seem in practice to be bound by the laws of lots of different places. Also code, sure.

But all contracts are bound by code, in the sense that the words of the contract are hopefully more or less unambiguous instructions for how an agreed upon project should be performed. Sometimes those instructions are interpreted by computers, other times by humans.  The reason that "law and jurisdiction" come into play is that sometimes stuff happens that is not addressed with perfect clarity in the contract. Sometimes the parties need to renegotiate to address something not specifically anticipated in the contract. Sometimes they can't agree, and need an outside adjudicator to decide what should happen. And sometimes the project affects people who never signed the contract in the first place, but who have a claim nevertheless.

So it's possible that the DAO might fund a proposal for Mobotiq, described like this:

Mobotiq's vision of modular Electric Vehicles that can be rented P2P is a perfect fit for the blockchain. Integration with Ethereum could enable the development of fully autonomous, self-renting vehicles.

(Don't miss the picture of the vehicle, or a vehicle, or a module of a vehicle.) But what if an impecunious owner of a Mobotiqmobile rents it to her impecunious peer, and it autonomously crashes into a bus full of children? What if they sue? What if Mobotiq, and the owner and the renter, don't have enough money to pay their damages? (Presumably the car has no money.) What if the insurance that Mobotiq is required to buy under the smart contract turns out to be worthless because someone filled out a form wrong? What if the only deep pockets anywhere near the accident are those of the DAO itself? What if the DAO has spent all its money on a pyramid scheme, and the only deep pockets are those of the DAO's individual investors?

At that point, the DAO might want to know what its relationship is with Mobotiq, not in terms of "immutable, unstoppable, and irrefutable computer code," but in terms of traditional corporate structures under relevant local law. Is Mobotiq a division of the DAO, identical with the DAO for liability purposes? Is it a separate corporation in which the DAO has a (limited liability) equity investment? The DAO's investors, similarly, might now be keenly interested in whether they are in fact general partners in the DAO under local law. Because general partners tend to have unlimited liability for their partnership's misdeeds.  Even if the smart contract says otherwise. Without the protections of limited liability based in local law, all you have to rely on is cryptography.  

Also, like, how does the DAO do its tax returns? 

Smart contracts are cool! Companies are weird bundles of contractual relationships that have become stereotyped and calcified over time, and re-imagining those relationships for a new and more technology-enabled age is a good project. But companies aren't just networks of contracts; they aren't pure agreements negotiated freely between willing participants and no one else. They are also structures that are embedded in society, with rights and responsibilities that are regulated by background rules as well as by contracts. The blockchain-y reinvention of everything in the financial world -- money, contracts, companies -- is fascinating and impressive and, viewed from a certain angle, adorable. But sometimes it could stand to learn from what has gone before. After all, the elements of finance -- money, contracts, companies -- have already been invented. Perhaps their historical development might hold some lessons for their re-inventors.

  1. Sometimes referred to as "The DAO," and sometimes, horrifyingly, written as like Eth-A-Omega.

  2. It goes without saying that nothing here is legal advice. In particular I stress that I make no judgment on whether The DAO would actually be treated as a general partnership under the law of any real-world jurisdiction.

  3. "A crowdfunded crowdfunding operation," says Ryder Taff on Twitter, not inaccurately. Or there is Homer Simpson: "a company that makes computers, or, a computer that makes companies."

  4. There is even a board-of-directors-ish function, the "Curators," who are in charge of making sure that no one gets 51 percent ownership and steals all the DAO's money. This is also a problem in regular corporations, actually! That's why controlled corporations tend to have special committees of independent directors for dealing with their controlling shareholders. 

  5. That code is TBD, I guess, since the address is. But for reference here is Slock.it's source code for the DAO's own smart contract. (Here is a related white paper.) 

  6. Within the world of the smart contract, of course. You could always try suing if you're disappointed! (Not legal advice, etc.)

  7. Oh I kid:

    Everything about it is new, Mr. Tual acknowledges, and will have to be tested in real-world situations. He said he has been in touch with government officials and regulators in a few European countries and is optimistic in what he has heard.

    “People make a big deal out of governments stomping on this stuff,” he said. “I think they’re going to embrace it.”

    Also, pleasingly, the DAOhub forums include a post arguing that "Establishing Legal Status Should be First Priority of DAO," and that post is controversial. Who needs law, when you have blockchains?

  8. The rough divide is that smart contracts are for computers, dumb contracts for humans, but not really. Banks tend to feed their derivatives contracts into computer systems, which then carry them out, and the DAO's smart contracts with its contractors would seem to require human intervention too.

  9. By the way, why would "immutable" be good in computer code? You want to have some flexibility to respond to unanticipated events by changing the contract. To be fair, it's not clear that immutability is actually a value of the DAO; its terms warn users that "The DAO’s smart contracts are continuously being developed and may undergo significant changes over time subject to the terms of such changes set forth in The DAO’s smart contract code."

  10. I suppose it's theoretically possible to handle this problem without deferring to existing courts. We've talked before about the idea of a blockchain-based distributed court system, which seems to be an area of interest for Ethereum. Here is Izabella Kaminska on blockchain courts. And here is Noah Smith at Bloomberg View on "high-frequency lawyers."

    Still it is not obvious to me that decentralized voting by strangers on contract interpretation is better than a regular court system.

  11. I mean, the smart contract doesn't even exist, I am just speculating that it would require insurance. Because: It would be a pretty dumb contract if it didn't!

  12. Still not legal advice! But it's in Wikipedia.

  13. Which, I mean, is not nothing. If no one can figure out who the DAO's owners are, then maybe it has, in effect, limited liability. But that's not what I'd want to lead with in talking to regulators.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net